market folly

Continuing coverage, we're posting up notes from the Value Investing Congress.  Below are notes and the presentation of Lloyd Khaner of Khaner Capital.  His talk was entitled 'Turnaround Investing - Swinging at Good Pitches.'

Khaner: 21 years, outperformed S&P 500.  Lost 6.5% last year.  Lost 14% in 2008. Made 63 successful turnarounds over the years.  Half large cap. Everything but biotech ("too hard").

Starbucks (SBUX) was his 2009 pick. Update on SBUX: it was midteens in 2009 when they pitched it, now $50 range.  Questions now on their new store growth- China, India.  Says they have a good person turning around Europe.  US store refresh on track.  "Verismo" product is not focused at GMCR K-cups, rather Nespresso. "La Boulange" bought concept to upgrade their food.  New concept of juice "Evolution Fresh."  His thesis is they are not over-expanding like they did last cycle. Deep management bench. Says stock could take a pause here in the 50s for a year or so. 


On Turnaround Investing

Common mistakes in turnaround investing:

1.  Swinging at bad pitches.  Too hard to do.
2.  Swinging too early.  Timing!
3.  Not swinging at all- fear and loathing (airlines, etc.) 

Bad Pitch #1:  Too Much Debt Balance sheet myopia, disadvantaged with customers, suppliers, competition.  Over 70% debt to capital- don't swing at this pitch 

#2: weak/non-turn around management.  Pass on it. 

#3:  weak/impaired industry. Becoming obsolete, irrational pricing, expensive financing.  Talent leaves, and never comes in.  Dying industry: don't do it!   Ted Williams analogy: he knew his exact batting average based on his hitting zones.  They did same thing. Zones to avoid: weak management, excess debt, dying industry.   Even at a good turnaround pitch, timing is everything. 


Investment Pitch on Jamba Juice (JMBA)

Only $208M market cap, sells about 1M shares/day 1990 IPO as SPAC, then March 2006 merged with Jamba Juice Company. 790 stores, 60% franchised, half in CA.  90 Jamba Go Stations, 40 international locations.  Building a CPG brand in 35k stores. Stores are small, 1200-1400 sq. ft., $700k average unit volume.  Lunch and afternoon is 50% of business.  Business spread evenly all day. Store only operating margin 20-23% and rising. Attachment rate (non-core products) is 20% Stores cost $265k-400k to build.

JambaGo is a self-serve unit for schools, institutions.  400-500 of these will be in public schools by the end of this year. No debt.  29M cash, management has turnaround experience, industry is growing.

The Whys?

Why did private equity save this company with cash in 2008? Why still improving comps despite competition from MCD? Why are they able to install JambaGo into public schools?

Their food is great, healthy, fairly affordable, for all ages, mom friendly, kid friendly, CPG brand in 35k locations, will be 50k by EOY2012. 

Risks: spike in food costs.  Speed of Service is slow, takes 5-10 minutes, limited seating in stores. 

What went wrong? Past management team was weak.  Too many employees 10k in stores, 250 in overhead, grew too quickly- in 2009 opened 99 on base of 600. Stores got run-down, dirty.  SSS dropped 8.1%.  Margins declined.  EPS and FCF negative in 2006, 7, 8.  Used short-term debt to fund the company. 

James White brought in Dec 2008 to turn it around.  Was SVP at SWY, and SVP at Gillete, worked for Jim Kilts, who turned G around. Three year plan:  hire new execs, retain talent, eliminate debt, reduced headcount at stores, refranchise company owned stores, forgo revenue at first to improve margins, improve food quality, clean the stores, expand the menu, extend the brand. He did all of this in 3 years.  Eliminated debt (converts) Closed 67 underperforming stores, refranchised 174 stores.

New goals: 4-6% SSS OM 20-23% SG&A flat. 40-50 new US locations JambaGO in 400-500 institutions Thesis:  eps positive $0.05, ROIC positive for first time in 5 years. 

New plan is about growth. Worldwide 3700 units, 400% growth, 1000 international.  Pipeline of 320 units already. 40 units now.  Double each year for a few years. JambaGO: 1500 by EOY2013. CPG royalties up to 10M from 3M this year. 

Valuation: Three year turnaround.  "Turnaround valuation" makes it look expensive. ROIC positive in 2012, 5-10%, up 2.5%/ year He predicts: eps .05 this year, 2013 22cents, 2015 50 cents If 15x eps, for 50 cents in 2015, $7.50 stock.   Timing is right, stock up from $1 to $2 already, but turnaround has progressed a lot already and potential to $5-6.

Question & Answer Session: 

1. Threat of competition of people making smoothies at home?  There is competition, that's why they are opening more stores.

2.  How do they source investments?  Usually they see the company first, other times CEO first.

3.  JCP?  He doesn't own it now.  Says it will be at least a 3 year turnaround.  Says they may have to go back to couponing; "that's retail."  Whitney Tilson mentions that before Johnson came in, 99.8% of items they sold were at some sort of discount.

4.  SHLD?  He doesn't own it, no turnaround CEO, over 10 years since they've taken care of it.  Asset value is a different question, but their segment of retail is very competitive.  Not a turnaround for a lot of reasons.

Embedded below is Khaner's slideshow presentation from the Value Investing Congress:




Check out the rest of the hedge fund presentations from the Value Investing Congress.